1. 16 Statement of Cash Flows Accounting 26e C H A P T E R Warren Reeve
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2. Reporting Cash Flows (slide 1 of 3)
The statement of cash flows reports a company’s cash inflows and outflows for a period.
The statement of cash flows provides useful information about a company’s ability to:
Generate cash from operations
Maintain and expand its operating capacity
Meet its financial obligations
Pay dividends
The statement of cash flows is used by managers in evaluating past operations and in planning future investing and financing activities.
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3. Reporting Cash Flows (slide 2 of 3)
It is also used by external users such as investors and creditors to assess a company’s profit potential and ability to pay its debt and pay dividends.
The statement of cash flows reports activities, as follows:
Cash flows from operating activities are the cash flows from transactions that affect the net income of a company.
Cash flows from investing activities are the cash flows from transactions that affect investments in the noncurrent assets of the company.
Cash flows from financing activities are the cash flows from transactions that affect the debt and equity of the company.
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4. Reporting Cash Flows (slide 3 of 3)
The cash flows are reported in the statement of cash flows as follows:
The ending cash on the statement of cash flows equals the cash reported on the company’s balance sheet at the end of the year.
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5. Sources and Uses of Cash
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6. Cash Flows from Operating Activities
Cash flows from operating activities reports the cash inflows and outflows from a company’s day-to-day operations.
Companies may select one of two alternative methods for reporting cash flows from operating activities in the statement of cash flows:
The direct method
The indirect method
Both methods result in the same amount of cash flow from operating activities. They differ in the way they report cash flows from operating activities.
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7. Cash Flows from Operating Activities: The Direct Method
The direct method reports operating cash inflows (receipts) and cash outflows (payments) as follows:
The primary operating cash inflow is cash received from customers.
The primary operating cash outflows are cash payments for merchandise, operating expenses, interest, and income tax payments.
The cash received from operating activities less the cash payments for operating activities is the net cash flow from operating activities.
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8. Cash Flows from Operating Activities: The Indirect Method
The indirect method reports cash flows from operating activities by beginning with net income and adjusting it for revenues and expenses that do not involve the receipt of cash or payment of cash, as follows:
The adjustments to reconcile net income to net cash flow from operating activities include such items as depreciation and gains or losses on fixed assets.
Changes in current operating assets and liabilities such as accounts receivable or accounts payable are also added or deducted, depending on their effect on cash flows.
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9. Cash Flows from Investing Activities
Cash flows from investing activities show the cash inflows and outflows related to changes in a company’s long-term assets.
Cash flows from investing activities are reported on the statement of cash flows as follows:
Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets.
Cash outflows normally include payments to purchase fixed assets, investments, and intangible assets.
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10. Cash Flows from Financing Activities
Cash flows from financing activities show the cash inflows and outflows related to changes in a company’s long-term liabilities and stockholders’ equity.
Cash flows from financing activities are reported on the statement of cash flows as follows:
Cash inflows from financing activities normally arise from issuing long-term debt or equity securities.
For example, issuing bonds, notes payable, preferred stock, and common stock creates cash inflows from financing activities.
Cash outflows from financing activities normally include paying cash dividends, repaying long-term debt, and acquiring treasury stock.
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11. Noncash Investing and Financing Activities
A company may enter into transactions involving investing and financing activities that do not directly affect cash.
For example, a company may issue common stock to retire long-term debt.
Because such transactions indirectly affect cash flows, they are reported in a separate section that usually appears at the bottom of the statement of cash flows.
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12. Cash flow per share is computed as follows:
No Cash Flow Per Share
Cash flow per share is computed as follows:
Cash flow per share should not be reported on a company’s financial statements for the following reasons:
Users may misinterpret cash flow per share as the per-share amount available for dividends.
Users may misinterpret cash flow per share as equivalent to (or better than) earnings per share.
Cash Flow per Share =
Cash Flow from Operations
Number of Common Shares Outstanding
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13. Preparing the Statement of Cash Flows— The Indirect Method
The indirect method of reporting cash flows from operating activities uses the logic that a change in any balance sheet account (including cash) can be analyzed in terms of changes in other balance sheet accounts:
Thus, by analyzing changes in the liability, stockholders’ equity, and noncash asset accounts, any change in the cash account can be indirectly determined:
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14. Adjustments to Net Income
Net income is normally adjusted to cash flows from operating activities, using the following steps:
Step 1. Expenses that do not affect cash are added. Such expenses decrease net income but not involve cash payments and, thus, are added to net income.
Step 2. Losses on the disposal of assets are added and gains on the disposal of assets are deducted.
Step 3. Changes in current operating assets and liabilities are added or deducted as follows:
Increases in noncash current operating assets are deducted.
Decrease in noncash current operating assets are added.
Increases in current operating liabilities are added.
Decreases in current operating liabilities are deducted.
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15. Preparing the Statement of Cash Flows— The Direct Method (slide 1 of 2)
The direct method reports cash flows from operating activities as follows:
The Cash Flows from Investing and Financing Activities sections of the statement of cash flows are exactly the same under both the direct and indirect methods.
The amount of net cash flow from operating activities is also the same, but the manner in which it is reported is different.
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16. Preparing the Statement of Cash Flows— The Direct Method (slide 2 of 2)
The Cash Flows from Investing and Financing Activities sections of the statement of cash flows are exactly the same under both the direct and indirect methods.
The amount of net cash flow from operating activities is also the same, but the manner in which it is reported is different.
Depreciation expense is not adjusted or reported as part of cash flows from operating activities.
This is because depreciation expense does not involve a cash outflow.
The gain on the sale of the land is also not adjusted and is not reported as part of cash flows from operating activities.
This is because the cash flow from operating activities is determined directly, rather than by reconciling net income. The cash proceeds from the sale of the land are reported as an investing activity.
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17. Converting Income Statement to Cash Flows from Operating Activities using the Direct Method
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18. Determining the Cash Received from Customers
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19. Determining the Cash Payments for Merchandise
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20. Determining the Cash Payments for Operating Expenses
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21. Determining the Cash Payments for Interest
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22. Determining the Cash Payments for Income Taxes
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23. Financial Analysis and Interpretation: Free Cash Flow (slide 1 of 2)
Free cash flow measures the operating cash flow available to a company to use after purchasing the property, plant, and equipment (PP&E) necessary to maintain current productive capacity.
Free cash flow is computed as follows:
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24. Financial Analysis and Interpretation: Free Cash Flow (slide 2 of 2)
Positive free cash flow is favorable.
A company that has free cash flow is able to fund internal growth, retire debt, pay dividends, and benefit from financial flexibility.
A company with no free cash flow is unable to maintain current productive capacity.
Lack of free cash flow can be an early indicator of liquidity problems.
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25. Appendix: Spreadsheet (Work Sheet) for Statement of Cash Flows—The Indirect Method
The steps in preparing this spreadsheet (work sheet) are as follows:
Step 1. List the title of each balance sheet account in the Accounts column.
Step 2. For each balance sheet account, enter its balance in the two Balance columns. Place the credit balances in parentheses.
Step 3. Add both of the Balance columns, which should total zero.
Step 4. Analyze the change during the year in each noncash account to determine its net increase (decrease) and classify the change as affecting cash flows from operating activities, investing activities, financing activities, or noncash investing and financing activities.
Step 5. Indicate the effect of the change on cash flows by making entries in the Transactions columns.
Step 6. After all noncash accounts have been analyzed, enter the net increase (decrease) in cash during the period.
Step 7. Add the Debit and Credit Transactions columns. The total should be equal.
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